European policymakers, particularly on the continent, have long appeared to be in denial over the systemic banking fragility that is central to the region’s problems. They have first denied the existence of a homegrown banking problem by shifting all the blame to Anglo-Saxons in 2007–09; then by engaging in timid, less-than-credible stress tests while redirecting the blame at the Greek government and other lousy fiscal managers in the European South. The October 2011 “recapitalization plan” was in effect another episode of denial, for various reasons: It was based on an unreliable capital assessment; and it assumed full fair value on sovereign debt, in violation of any prudential principles. It also relied on overly volatile debt prices, a dubious basis for capital assessments even at amortized cost, given the huge uncertainties about the euro area’s future fiscal framework. The European Central Bank (ECB) then had little choice but to provide Europe’s entire banking system with an expanded lifeline of long-term liquidity, as it did in December to great effect with the three-year Long Term Refinancing Operations (LTRO).

In this sorry context, it is good news that a more lively debate seems to have emerged these days over the need for a European banking union as a necessary complement to a euro area fiscal union, as the Financial Timesrecently reported. Some observers, including Jacob Kirkegaard, see the emergence of an integrated European banking policy in the making.

This view may be too optimistic, however. There is widespread agreement among economists and European and international technocrats that Europe’s single financial market and monetary union cannot survive long-term without a banking union. Many observers had defended this view since before the crisis started (me included), and the International Monetary Fund articulated it more specifically in a landmark contribution[pdf] in April 2010, which the then Managing Director endorsed in a speech in Brussels. But the obstacles are political, not analytical, and they have not disappeared at all.

Put simply, Europe’s leaders are not ready to create a truly meaningful federal framework for banking policy because a critical mass of countries sees banks as a core instrument of national policy. Financial repression—namely, governments harnessing national financial systems to reduce their own financial difficulties to the detriment of savers and other users of financial services—is back from the history books, arguably even more so in the euro area than in other so-called advanced economies. A true banking union would encompass a federal framework for banking policy, including regulation, deposit insurance, and supervision and resolution at least for transnational banks. The catch is that this would also deprive national governments of many of their levers for financial repression. Other political considerations would also discourage such a union, including strong local links between banking and political establishments (e.g., Germany or Spain) to economic nationalism (e.g., France), that create huge political resistances to the very notion of a banking union.

An additional obstacle, not to be underestimated, is the discrepancy between the euro area and the 27-member European Union. A euro area–only banking union would be very difficult to square with the vision of a single EU market for financial services. Meanwhile, the European Banking Authority, created in 2011, happens to be located in London. But the United Kingdom is not ready to federalize decisions on banking supervision and resolution, partly because its big banks’ international activities are outside Europe rather than on the continent (see figure 5 here[pdf]). There is no easy answer to this challenge, particularly because nobody knows what direction the United Kingdom will take vis-à-vis the European Union over the medium-term. Even policymakers who forcefully advocate for a banking union, as the ECB’s Benoit Coeuré did in a recent speech, stop short of specifying whether they have a euro area or EU-27 framework in mind. Senior policymakers acknowledge in private that this is a huge practical obstacle to progress on the way to a banking union, and it is not likely to be resolved any time soon.

Ultimately, monetary union cannot be sustainable without fiscal union and banking union, and these will not themselves be sustainable without a form of political union. (I analyzed this interdependency in my testimony to the US Senate last September.) But my hunch is that there is a sequence here: We had monetary union first, we will (possibly) have fiscal union next, and (if at all) banking union last. Contrary to many people’s intuitive perception, it is politically easier for a nation to renounce its own currency and even its fiscal sovereignty than its control on banks. The US history is not directly comparable but suggests the same sequence, as a truly integrated American national banking market did not exist until the second half of the 20th century. The apparent new emphasis on banking union in Europe’s policy debate must be welcomed, but we’re still a very, very long way from the endgame.